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https://www.barrons.com/articles/3-cheap-growth-stocks-1408475500

Ahead of the Crowd

3 Cheap Growth Stocks

By

Jack Hough

August 19, 2014

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The stock market's bargain bin has been picked nearly clean. Just a dozen stocks in the Standard & Poor's 500 have price-to-earnings ratios in the single digits. A year ago there were 41. A year before that, there were 154.

Rather than settle for the handful of deep-value stocks on offer, investors should consider paying higher prices for companies with much better growth potential. Peter Tuz, president of Chase Investment Counsel and co-manager of the Chase Growth Fund (ticker:
CHASX
), cites three he has been buying lately: O'Reilly Automotive (
ORLY
), Fiserv (
FISV
) and Cameron International (
CAM
).

One reason to favor growth stocks now is that ravenous demand for value shares has left growth trading at a smaller-than-usual premium. A statistical analysis of S&P 500 price-to-earnings ratios shows they're more tightly clustered than they have been on average since 1990. When valuations are clumped together, it is a sign that stocks with strong growth characteristics are relatively good deals.

Consider the contrast between two exchange-traded funds: SPDR S&P 500 Growth (
SPYG
) and SPDR S&P 500 Value (
SPYV
). The growth fund trades at 18.9 times prospective earnings, versus 15.3 times for the value fund, according to Morningstar. But the growth fund has an underlying sales-growth rate of 8.1%, versus 0.8% for the value fund. The drastic difference in growth rates makes the value fund look like the pricier of the two.

Returning to Tuz's picks, O'Reilly Automotive recently traded for $154 a share. The stock has gained an average of 32.4% a year, compounded, in the past five years, versus 14.6% for the S&P 500. The car-parts chain, which fetches 21.5 times this year's earnings forecast, looks like a good deal to Wedbush Securities, too. The firm published a note on the stock on Tuesday looking for 17% more upside over the next year. A new Florida distribution center should support aggressive growth in the state, and O'Reilly's long-term formula of 5% yearly store growth, 3% to 5% growth in same-store sales, and 0.4 percentage points of operating-margin expansion look intact, according to Wedbush. Wall Street sees earnings per share growing 19% this year to $7.15 and topping $12 a share by 2018.

Fiserv provides electronic payment and other online banking services for financial companies. Shares have gained an average of 21.6% in the past five years and trade at 18.9 times this year's earnings forecast. Tuz calls the stock a relatively inexpensive way to buy exposure to the fast-growing electronic payment industry. Earnings per share are expected to rise by 12% a year in the next three years. And the company's earnings understate its free cash flow. Based on next year's forecasts, shares go for 14.7 times free cash.

Cameron International makes valves, chokes and blowout preventers used by oil and gas drillers. Gabelli & Co. calls the stock its favorite idea for August 2014. Cameron management has raised earnings guidance twice this year, including late last month when it cited improvement in its largest business, Drilling and Production Systems.

Wall Street expects Cameron's earnings per share to grow 26% this year to $4.15, and 24% next year to $5.15. That puts the shares, recently $72, at 17.3 times this year's forecast and just 14 times next year's. Gabelli predicts that free cash flow will total $20 a share between 2014 and 2018, or about 28% of the share price. Cameron has a recent record of putting cash to lucrative use: It has repurchased nearly 20% of its shares since the beginning of 2013, paying an average price of $58 a share.

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